IFRS & EEV Restatement 311204
Legal & General Group PLC
24 May 2005
Part C
Legal & General Group Plc
EEV financial information
-------------------------------------------------------------------------------
Index
Consolidated Income Statement 1
Consolidated Balance Sheet 2
Statement of Recognised Income and Expense 2
Methodology
Basis of preparation 3
Covered business 3
Description of methodology 3
Embedded value 3
Service companies 4
New business 4
Projection assumptions 4
Tax 5
Allowance for risk 5
Required capital and free surplus 5
Financial options and guarantees 6
Risk discount rate 7
Analysis of profit 8
Notes to Financial Statements 10
Assumptions 16
Reconciliations
Reconciliation of shareholders' equity 20
Reconciliations from AP to EEV 21
Audit Report 22
===============================================================================
Legal & General Group Plc P1
Consolidated Income Statement - EEV Basis
Year ended 31 December 2004
-------------------------------------------------------------------------------
Notes
EEV AP
£m £m
Profit on continuing operations
Life and pensions
- UK 1 474 494
- USA 72 73
- Netherlands 30 32
- France 11 14
-------- --------
587 613
Institutional fund management 104 103
General insurance 32 32
Other operational income 22 34
-------- --------
Operating profit on continuing operations 745 782
Profit on discontinuing operations 7 7
-------- --------
Operating profit 752 789
Variation from longer term investment return 2 414 408
Change in equalisation provision - (7)
Effect of economic assumption changes 1 34 32
Property income attributable to minorities 32 -
-------- --------
Profit before tax 1,232 1,222
Tax (351) (352)
-------- --------
Profit for the period 881 870
Minority interests 3 (32) -
-------- --------
Profit attributable to equity holders 849 870
======== ========
Basic earnings per share p p
Based on operating profit after tax 8.35 8.80
Based on profit for the financial period 13.10 13.40
Diluted earnings per share
Based on operating profit after tax 8.19 8.57
Based on profit for the financial period 12.72 12.97
===============================================================================
Legal & General Group Plc P2
Consolidated Balance Sheet - EEV Basis
Year ended 31 December 2004
-------------------------------------------------------------------------------
Notes
EEV AP
£m £m
Assets
Investments 7 147,761 146,700
Reinsurers' share of contract provisions 2,977 2,977
Long term in-force business asset 2,535 2,764
Other debtors 2,111 1,934
Non-current assets held for sale 733 -
-------- --------
156,117 154,375
======== ========
Liabilities
Shareholders' equity 9 6,182 6,116
Minority interests 214 -
Technical provisions 144,569 141,990
-------- --------
150,965 148,106
Borrowings 8 1,846 1,788
Other creditors 2,672 4,481
Non-current liabilities held for sale 634 -
-------- --------
156,117 154,375
======== ========
Statement of Recognised Income and Expense
Year ended 31 December 2004
-------------------------------------------------------------------------------
EEV AP
£m £m
Fair value losses on cash flow hedges (4) -
Exchange differences on translation of foreign operations (8) (9)
Pension fund actuarial losses (26) -
Net change in available for sale investments (2) -
-------- --------
Net income recognised directly in equity (40) (9)
Profit for the year 881 870
Dividends (321) (329)
-------- --------
Total recognised income and expense for the year 520 532
Minority interests (32) -
-------- --------
Attributable to equity holders of the company 488 532
===============================================================================
Legal & General Group Plc P3
Methodology
Year ended 31 December 2004
-------------------------------------------------------------------------------
Basis of Preparation
The purpose of this section is to set out the detailed methodology for producing
the Group's supplementary financial statements. The statements have been
prepared in accordance with the European Embedded Value (EEV) Principles issued
in May 2004 by the European CFO Forum. Due to the continuing work of the CFO
Forum and the IASB, and the possible amendment to the interpretive guidance, the
Group's accounting policies and consequently, the information presented may
change prior to the publication of the Group's first published Interim EEV and
IFRS results in July 2005.
These supplementary financial statements have been audited by
PricewaterhouseCoopers LLP and prepared in conjunction with our consulting
actuaries - Tillinghast Towers-Perrin and, in the US, Milliman USA.
Covered Business
The Group uses EEV methodology to value Individual and Group life assurance,
pensions and annuity business written in the UK, Continental Europe and the US
and our UK managed funds business.
All other business units are accounted for on the IFRS basis adopted in the
primary financial statements.
Under EEV, there is no distinction made between insurance and investment
contracts in our life and pensions businesses as there is under IFRS.
Description of Methodology
The objective of EEV is to provide shareholders with more realistic information
on the financial position and current performance of the Group than is provided
within the primary financial statements.
The methodology requires assets of an insurance company as reported in the
primary financial statements to be attributed between those supporting the
covered business (restricted assets) and the remainder (residual assets). The
method accounts for assets as follows:
i. restricted assets on an EEV basis; and
ii. residual assets on the IFRS basis adopted in the primary financial
statements.
The EEV methodology recognises as profit from the covered business the total of:
i. cash transfers during the relevant period from the covered business
to the residual assets, as determined following a statutory valuation; and
ii. the movement in the present value of the expected future cash flows
from the covered business to the residual assets over the relevant period.
Embedded Value
Shareholders' equity on the EEV basis comprises the embedded value of the
covered business plus the balance of shareholders' equity on the IFRS basis,
less the value included for purchased interests in long term business.
The embedded value is the sum of the shareholder net worth (SNW) and the value
of the in-force business (VIF). SNW is defined as those amounts, held either in
the UK Long Term Fund (LTF) or by other companies writing long term business,
which are regarded either as required capital for the covered business or which
represent surplus assets within those companies.
===============================================================================
Legal & General Group Plc P4
Methodology
Year ended 31 December 2004
-------------------------------------------------------------------------------
The VIF is the present value of the distributable profits to shareholders
arising from the covered business, projected using best estimate assumptions,
less an appropriate deduction for the cost of holding the required level of
capital and the time value of financial options and guarantees.
Service Companies
All services relating to the UK life and pensions business, including investment
management services, are charged on a cost recovery basis.
New Business
New business premiums reflect income arising from the sale of new contracts
during the reporting period and any changes to existing contracts which were not
anticipated at the outset of the contract.
In force business comprises previously written single premium, regular premium
and recurrent single premium contracts.
DWP rebates have not been treated as recurrent and they are included in new
business when received.
New business contribution arising from the new business premiums written during
the reporting period has been calculated on the same economic and operating
assumptions used in the embedded value at the end of the financial period. This
has then been rolled forward to the end of the financial period using the risk
discount rate applicable at the end of the reporting period.
Traditionally, new business margins have been defined as new business
contribution at the end of the reporting period divided by the annual premium
equivalent. Under EEV a new measure, the present value of future new business
premiums (PVNBP), has been calculated and expressed at the point of sale. The
PVNBP is equivalent to the total single premiums plus the discounted value of
regular premiums expected to be received over the term of the contracts using
the same economic and operating assumptions used for the embedded value at the
end of the financial period. A revised new business margin has been defined
under EEV as new business contribution at the end of the reporting period
divided by the PVNBP. The premium volumes and projection assumptions used to
calculate the PVNBP are the same as those used to calculate new business
contribution.
Projection Assumptions
Cash flow projections are determined using realistic assumptions for each
component of cash flow and for each policy group. Future economic and investment
return assumptions are based on year end conditions. Future investment returns
are projected by one of two methods. The first method is based on an assumed
investment return attributed to assets at their market value. The second, which
is used in the US, where the investments of that subsidiary are substantially
all fixed interest, projects the cash flows from the current portfolio of assets
and assumes an investment return on reinvestment of surplus cash flows. The
assumed discount and inflation rates are consistent with the investment return
assumptions.
Detailed projection assumptions including mortality, persistency, morbidity and
expenses reflect recent operating experience and are reviewed annually.
Allowance is made for future improvements in annuitant mortality based on
experience and externally published data. Favourable changes in operating
experience are not anticipated until the improvement in experience has been
observed.
===============================================================================
Legal & General Group Plc P5
Methodology
Year ended 31 December 2004
-------------------------------------------------------------------------------
All costs relating to the covered business, whether incurred in the covered
business or elsewhere in the Group, are allocated to that business. The expense
assumptions used for the cashflow projections therefore include the full cost of
servicing this business.
Tax
The projections take into account all tax which is expected to be paid under
current legislation, including tax which would arise if surplus assets within
the covered business were eventually to be distributed.
Allowance for Risk
Aggregate risks within the covered business are allowed for through the
following principal mechanisms:
i. Setting required capital levels with reference to both the Group's
internal risk based capital models, and an assessment of the strength of
regulatory reserves in the covered business;
ii. Allowing explicitly for the time value of financial options and
guarantees (FOGs) within the Group's products; and
iii. Setting risk discount rates by deriving a Group level risk margin to
be applied consistently to local risk free rates.
Required Capital and Free Surplus
Regulatory capital for UK life and pensions business is provided by assets
backing the with-profits sub-fund or by the SNW. The SNW comprises the
Shareholder Retained Capital (SRC) and the Sub-Fund.
For the UK with-profits sub-fund, the required capital will be covered by the
surplus within the fund and no effect will be attributed to shareholders except
for the burn-through cost which is described later. This treatment is consistent
with the Principles and Practices of Financial Management for this fund.
For UK non profit business, the required capital will be maintained at no less
than the level of the EU minimum solvency requirement. This level together with
the margins for adverse deviation in the regulatory reserves is, in aggregate,
in excess of internal capital targets assessed in conjunction with the
Individual Capital Assessment (ICA) exercise.
The SRC is either required to cover EU solvency margin or is encumbered because
its distribution to shareholders is restricted due to previous understandings
with the FSA. It is therefore classified as required capital. SRC is valued by
assuming it is distributed from the LTF over a 20 year period with allowance for
tax payable on distribution. For this purpose, distribution of the SRC is
restricted such that there is always sufficient SRC and subordinated debt left
to cover the EU solvency margin for non profit business.
The initial strains relating to new non profit business, together with the
related EU solvency margin, are supported by releases from existing non profit
business and the SRC. As a consequence, the writing of new business defers the
release of capital from the SRC to free surplus. As the investment return, net
of tax, on that capital is less than the risk discount rate, there is a
resulting cost of capital which is reflected in the value of new business. Cost
of holding required capital is defined as the difference between the value of
the required capital and the present value of future releases of that capital.
For new business, the cost of capital is taken as the difference in the value of
that capital assuming it was available for release immediately and the present
value of the future releases of that capital.
===============================================================================
Legal & General Group Plc P6
Methodology
Year ended 31 December 2004
-------------------------------------------------------------------------------
The Sub-Fund is also treated as required capital, because its distribution to
shareholders is restricted by Legal & General Assurance Society's Articles of
Association.
For our UK managed pension funds business, risk based capital has been used to
model required capital. The balance of net assets within the UK Managed Funds
business is treated as free surplus.
For L&G America, the Company Action Level (CAL) of capital has been treated as
required capital for modelling purposes. The CAL is the regulatory capital level
at which the company would have to take prescribed action, such as submission of
plans to the state insurance regulator, but would be able to continue operating
on the existing basis. The CAL is currently twice the level of capital at which
the regulator is permitted to take control of the business.
For L&G Netherlands (LGN), required capital has been set at 100% of EU minimum
solvency for all products which do not have any related FOGs. For those products
with FOGs, capital of between 112.5% and 175% of the EU minimum solvency margin
has been used. The level of capital has been determined using risk based capital
techniques.
In France (LGF), 100% of EU minimum solvency margin has been used for EV
modelling purposes for all products without FOGs. For those products with FOGs,
200% of EU minimum solvency margin has been used. The level of capital has been
determined using risk based capital techniques.
The contribution from new business for our Overseas businesses reflects an
appropriate allowance for the cost of holding the required capital.
Financial Options and Guarantees
In the UK, all financial options and guarantees (FOGs) are within the UK Life &
Pensions business.
Under the EEV Principles an allowance for time value of FOGs is required where a
financial option exists which is exercisable at the discretion of the
policyholder. These types of option principally arise within the with-profits
sub-fund and their time value is recognised within the with-profits burn-through
cost described below. Additional financial options within the non profit fund
exist only for a small amount of deferred annuity business where guaranteed
early retirement and cash commutation terms apply when the policyholder chooses
their actual retirement date.
Further financial guarantees exist within the non profit fund, in relation to
index-linked annuities where capped or collared restrictions apply. Due to the
nature of these restrictions and how they vary depending on the prevailing
inflation conditions we have also treated these as FOGs and recognised a time
value cost of FOG accordingly.
The time value of FOGs has been calculated stochastically using a large number
of real world economic scenarios derived from assumptions consistent with the
deterministic EEV assumptions and allowing for appropriate management actions
where applicable. The management action primarily relates to the setting of
bonus rates where for example future regular and terminal bonuses on
participating business within the projections are set in a manner consistent
with expected future returns available on assets deemed to back the policies
within the stochastic scenarios.
In recognising the residual value of any projected surplus assets within the
with-profits sub-fund in the deterministic projection, it is assumed that
terminal bonuses are increased to exhaust all of the assets in the fund over the
future lifetime of the in-force with-profits policies. However, under stochastic
modelling there may be some extreme economic scenarios when the total projected
assets within the with-profits sub-fund are insufficient to pay all projected
policyholder claims and associated costs.
===============================================================================
Legal & General Group Plc P7
Methodology
Year ended 31 December 2004
------------------------------------------------------------------------------
The average additional shareholder cost arising from this shortfall has been
included in the time value cost of options and guarantees and is referred
to as the with-profits burn-through cost.
The same economic scenarios have been used to assess the time value of the
financial guarantees within the non profit fund by using the inflation rate
generated in each scenario. The inflation rate used to project index-linked
annuities will be constrained in certain real world scenarios, for example where
negative inflation occurs but the annuity payments do not reduce below
pre-existing levels. The time value cost of FOGs allows for the projected
average cost of these constrained payments for the index-linked annuities. The
time value cost of FOGs also allows for the small additional cost of the
guaranteed early retirement and cash commutation terms for the minority of
deferred annuity business where such guarantees have been written.
In the US, financial options and guarantees relate to guaranteed minimum
crediting rates and surrender values on a range of contracts. The guaranteed
surrender value of the contract is based on the accumulated value of the
contract including accrued interest. The crediting rates are discretionary but
related to the accounting income for the amortising bond portfolio. The majority
of the guaranteed minimum crediting rates are between 4% and 5%. The assets
backing these contracts are invested in US dollar denominated fixed interest
securities.
In the Netherlands, there are two types of guarantees: interest rate guarantees
and maturity guarantees. Certain contracts provide an interest rate guarantee
where there is a minimum crediting rate based on the higher of 1-year Euribor
and the policy guarantee rate. In accordance with market practice, it is
expected that guarantees will be financed from unrealised gains on assets. This
guarantee applies on a monthly basis. Certain unit linked contracts provide a
guaranteed minimum value at maturity where the maturity amount is the higher of
the fund value and a guarantee amount. The fund values for both these contracts
are invested in Euro denominated fixed interest securities.
In France, financial options and guarantees relate to guaranteed minimum
crediting rates and surrender values on a range of contracts. The guaranteed
surrender value of the contract is the accumulated value of the contract
including accrued bonuses. The bonuses are based on the accounting income for
the amortising bond portfolios plus income and releases from realised gains on
any equity type investments. Policy liabilities equal guaranteed surrender
values. Local statutory accounting rules require the establishment of a specific
liability when the accounting income for a company is less than 125% of the
guaranteed minimum credited returns however this has never been required. In
general, the guaranteed annual bonus rates are between 2% and 4.5%.
Risk Discount Rate
The risk discount rate (RDR) is a combination of the risk free rate and a risk
margin, which reflects the residual risks inherent in the Group's covered
businesses, after taking account of prudential margins in the statutory
provisions, the required capital and the specific allowance for financial
options and guarantees.
The risk margin has been determined based on an assessment of the Group's
weighted average cost of capital (WACC). This assessment incorporates a beta for
the Group which measures the correlation of movements in the Group's share price
to movements in a relevant index. Beta values therefore allow for the market's
assessment of the risks inherent in the business relative to other companies in
the chosen index.
The WACC is derived from the Group's cost of equity and debt, and the proportion
of equity to debt in the Group's capital structure measured using market values.
Each of these three parameters should be forward looking, although informed by
historic information. The cost of equity is calculated as the risk free rate
plus the equity risk premium for the chosen index multiplied by the company's
beta. Forward-looking or adjusted betas make allowance for the observed tendency
for betas to revert to 1 and therefore a weighted average of the historic beta
and 1 tends to be a better estimate of the company's beta for the future period.
We have computed the WACC using an arithmetical average of forward-looking betas
against the FTSE 100 index.
===============================================================================
Legal & General Group Plc P8
Methodology
Year ended 31 December 2004
-------------------------------------------------------------------------------
The cost of debt used in the WACC calculations takes account of the actual
locked-in rates for our senior and subordinated long term debt. For the Group's
convertible debt, which matures in 2006, the probability of conversion is
considered low given current market conditions. The cost of debt therefore
assumes an equivalent long term market cost for this debt based on 5-year swap
rates rather than the actual rate of 2.75%. All debt attracts tax relief at a
rate of 30%.
Whilst the WACC approach is a relatively simple and transparent calculation to
apply, subjectivity remains within a number of the assumptions. Management
believe that the chosen margin, together with the levels of required capital,
the inherent strength of the Group's regulatory reserves and the explicit
deduction for the cost of options and guarantees, is appropriate to reflect the
risks within the covered business.
A similar approach will be adopted when risk margins are reassessed in future
periods. Currently, we do not expect the risk margin to change significantly
during 2005.
Key assumptions are set out below:
Risk free rate: Derived from gross redemption yields on relevant gilt
portfolio
Equity risk premium 3.0% (UK only)
Property risk premium 2.0% (UK only)
Risk margin 3.0%
The risk margin has been calculated by assuming a debt ratio of 20%, a net cost
of debt of 3.9% p.a. and an average beta of 1.35. In addition, the margin allows
specifically for the risks covered by the time value of financial options and
guarantees (deduction of 0.1%).
Analysis of Profit
Operating profit is identified at a level which reflects an assumed longer term
level of investment return.
The contribution to operating profit in a period is attributed to four sources:
i. new business;
ii. the management of in-force business;
iii. development costs; and
iv. return on shareholder net worth.
Further profit contributions arise from actual investment return differing from
the assumed long term investment return (investment return variances), and from
the effect of economic assumption changes.
The contribution from new business represents the value recognised at the end of
each period from new business written in that period, after allowing for the
actual cost of acquiring the business and of establishing the required technical
provisions and reserves and after making allowance for the cost of capital. New
business contributions are calculated using closing assumptions.
===============================================================================
Legal & General Group Plc P9
Methodology
Year ended 31 December 2004
-------------------------------------------------------------------------------
The contribution from in-force business is calculated using opening assumptions
and comprises:
i. expected return - the discount earned from the value of business
in-force at the start of the year;
ii. experience variances - the variance in the actual experience over the
reporting period from that assumed in the value of business in-force as at the
start of the year; and
iii. operating assumption changes - the effects of changes in future
assumptions, other than changes in economic assumptions from those used in
valuing the business at the start of the year. These changes are made
prospectively from the end of the year.
Development costs are associated with investment in building a new enterprise or
exceptional development activity over a defined period.
The contribution from shareholder net worth comprises the increase in embedded
value based on assumptions at the start of the year in respect of:
i. encumbered assets within the covered business - principally the
unwind of the discount rate; and
ii. residual assets - the expected investment return.
Investment return variances represent the effect of actual investment
performance and changes to investment policy on shareholder net worth and
in-force business from that assumed at the beginning of the period.
Economic assumption changes comprise the effect of changes in economic
variables, beyond the control of management, including associated changes to
valuation bases to the extent that they are reflected in revised assumptions.
===============================================================================
Legal & General Group Plc P10
Notes to Financial Statements - EEV Basis
Year ended 31 December 2004
-------------------------------------------------------------------------------
1. Profit for the period from covered business
Life and pensions Managed
Intern- pension
UK ational Total funds Total
£m £m £m £m £m
2004 - EEV
Contribution from:
New business after cost of
capital 241 35 276 36 312
In-force business
- expected return 273 49 322 18 340
- experience variances 46 17 63 15 78
- operating assumption changes (221) 1 (220) 18 (202)
Development costs - - - (1) (1)
Shareholder net worth 135 11 146 6 152
-------- -------- -------- -------- --------
Operating profit 474 113 587 92 679
Variation from longer term
investment return 363 3 366 11 377
Effect of economic
assumption changes 15 19 34 0 34
-------- -------- -------- -------- --------
Profit before tax 852 135 987 103 1,090
Tax (238) (46) (284) (31) (315)
-------- -------- -------- -------- --------
Profit for the period 614 89 703 72 775
======== ======== ======== ======== ========
2004 - AP
Contribution from:
New business 272 45 317 36 353
In-force business
- expected return 267 50 317 17 334
- experience variances 43 14 57 16 73
- operating assumption changes (219) 1 (218) 17 (201)
Development costs - - - (1) (1)
Shareholder net worth 131 9 140 6 146
-------- -------- -------- -------- --------
Operating profit 494 119 613 91 704
Variation from longer term
investment return 364 0 364 12 376
Effect of economic
assumption changes 15 17 32 0 32
-------- -------- -------- -------- --------
Profit before tax 873 136 1,009 103 1,112
Tax (244) (46) (290) (31) (321)
-------- -------- -------- -------- --------
Profit for the period 629 90 719 72 791
===============================================================================
Legal & General Group Plc P11
Notes to Financial Statements - EEV Basis
Year ended 31 December 2004
-------------------------------------------------------------------------------
2. Variation from longer term investment return
EEV AP
£m £m
Total covered business 377 376
####### #######
Institutional fund management : 0 : : 0 :
General insurance : (3): : (3) :
Other operational income : 40 : : 35 :
####### #######
37 32
-------- --------
414 408
======== ========
Investment return variances represent the effect of actual investment
performance and changes to investment policy in respect of shareholder net worth
and in-force business compared with assumptions at the beginning of the period.
3. Minority interests
Minority interests represents the share of profit relating to investments
included in the consolidated balance sheet that are owned by third parties.
4. Present value of new business premiums (PVNBP)
Capital- New
Single Regular isation business
premiums premiums factor PVNBP margin
£m £m £m %
UK 3,740 348 4.3 5,255 4.6
International 272 77 6.9 802 4.4
-------- -------- -------- --------
4,012 425 6,057 4.6
======== ======== ======== ========
The PVNBP on the EEV basis is defined as the present value of regular premiums
plus single premiums for any given year. It is calculated using the same
assumptions as for the new business contribution. There are no equivalent
figures on the AP basis.
The capitalisation factor represents the PVNBP minus single premiums divided by
the annualised amount of new regular premiums.
===============================================================================
Legal & General Group Plc P12
Notes to Financial Statements - EEV Basis
Year ended 31 December 2004
-------------------------------------------------------------------------------
5. Time value of options and guarantees
EEV
£m
Life and pensions
- UK
- With-profits guarantees 8
- Non profit guarantees 24
--------
32
- International 8
--------
Total time value of options and guarantees 40
========
6. Embedded value
Life and pensions Managed
Intern- pension
UK ational Total funds Total
£m £m £m £m £m
Year ended 31.12.04 - EEV
At 1 January
Value of in-force busines 2,552 377 2,929 158 3,087
Shareholder net worth * 1,569 245 1,814 143 1,957
-------- -------- -------- -------- --------
4,121 622 4,743 301 5,044
Exchange rate movements - (28) (28) - (28)
-------- -------- -------- -------- --------
4,121 594 4,715 301 5,016
Profit for the period 614 89 703 72 775
Capital movements - 25 25 - 25
Distributions (274) (1) (275) (20) (295)
Movement in pension deficit (16) - (16) - (16)
###### ###### ###### ###### ######
Value of in-force business :2,885: : 431: :3,316: : 191 : : 3,507:
Shareholder net worth * :1,560: : 276: :1,836: : 162 : : 1,998:
###### ###### ###### ###### ######
At 31 December 4,445 707 5,152 353 5,505
======== ======== ======== ======== ========
Year ended 31.12.04 - AP
At 1 January 4,253 657 4,910 305 5,215
Exchange rate movements - (29) (29) - (29)
-------- -------- -------- -------- --------
4,253 628 4,881 305 5,186
Profit for the period 629 90 719 72 791
Capital movements - 25 25 - 25
Distributions (274) (1) (275) (20) (295)
-------- -------- -------- -------- --------
At 31 December 4,608 742 5,350 357 5,707
======== ======== ======== ======== ========
comprising:
Value of in-force business 3,007 499 3,506 194 3,700
Shareholder net worth * 1,601 243 1,844 163 2,007
-------- -------- -------- -------- --------
4,608 742 5,350 357 5,707
======== ======== ======== ======== ========
* For the UK life and pensions business, shareholder net worth comprises the
shareholder retained capital (SRC) on the IFRS basis for EEV and MSS basis for
AP, adjusted for deferred acquisition costs, deferred tax and sterling reserves,
and the Sub-Fund, both net of an appropriate allowance for tax. It also includes
intra-group subordinated debt capital at its face value of £602m.
Shareholder net worth comprises both required capital and free surplus. Free
surplus amounted to £310m at 31 December 2004 (2003: £245m) comprising UK life
and pensions, £nil (2003: £nil); International life and pensions, £166m (2003:
£120m); Managed Pension Funds, £144m (2003: £125m).
Value of in-force business reflects a cost for holding capital of £58m at 31
December 2004 (2003: £55m) comprising UK life and pensions, £8m (2003: £8m);
International life and pensions, £48m (2003: £45m); Managed Pension Funds, £2m
(2003: £2m).
===============================================================================
Legal & General Group Plc P13
Notes to Financial Statements - EEV Basis
Year ended 31 December 2004
-------------------------------------------------------------------------------
7. Funds under management
EEV AP
£m £m
Investment property 4,903 3,741
Shares, variable yield securities and unit trusts - 11,529
Equities 78,322 -
Unit trusts 1,875 -
Debt and other fixed income securities - 21,677
Debt securities 58,604 -
Accrued interest 753 -
Derivative assets 23 -
Deposits with credit institutions - 941
Loans and receivables 289 567
Assets held to cover linked liabilities - 108,297
Amounts payable under a margining arrangement - (119)
Cash and cash equivalents 2,992 67
-------- --------
147,761 146,700
Other funds 447 -
-------- --------
Funds included in the consolidated balance sheet 148,208 146,700
Segregated funds 11,098 11,098
Unit trusts, ISAs and PEPs 7,919 7,949
-------- --------
Total funds under management 167,225 165,747
======== ========
IAS32 and 39, 'Financial Instruments' require that all investments are split
into their respective asset classes.
8. Borrowings
EEV AP
£m £m
2.75% Convertible bond 2006 493 521
Undated subordinated notes 394 394
Medium Term Notes 2031-2041 597 597
Bank loans 2005 2 1
Accrued interest 17 -
-------- --------
Core debt 1,503 1,513
Non recourse financing
- Triple X 2025 275 275
- Property Partnership loans 2011 68 -
-------- --------
Total borrowings 1,846 1,788
======== ========
The convertible bond matures in 2006 and is convertible into ordinary shares of
the Company at 184p per share. If converted, this bond would give rise to the
issue of 285.3m new ordinary shares which represents approximately 4.4% of the
current issued share capital. On conversion, the bonds may be settled in shares
or in cash at the option of the Company.
The fair value of the conversion option was calculated on issue using an option
pricing model. This is recognised as a derivative liability and is revalued to
fair value at each reporting period. Fair value gains and losses are taken
through the income statement. The remainder of the proceeds less attributable
expenses were allocated to the value of the debt portion of the convertible
bond. This amount is recorded as a liability on an amortised cost basis until
extinguished on conversion or maturity of the bond.
In November 2004 a subsidiary of Legal & General America issued US$550m of
non-recourse debt in the US domestic capital markets as floating rate Dutch
Auction Market Securities due 2025. The transaction provides capital to meet the
Regulation Triple X reserve requirements on the US term insurance business
without affecting the Group's debt capacity or financial gearing.
===============================================================================
Legal & General Group Plc P14
Notes to Financial Statements - EEV Basis
Year ended 31 December 2004
-------------------------------------------------------------------------------
9. Shareholders' equity segmental analysis
EEV AP
£m £m
Embedded value of life and pensions businesses:
- UK * 4,445 4,608
- USA 489 504
- Netherlands 139 144
- France 79 94
-------- --------
5,152 5,350
Institutional fund management ** 390 393
-------- --------
5,542 5,743
General insurance 149 149
Corporate funds *** 491 224
-------- --------
6,182 6,116
======== ========
Movement
At 1 January 5,680 5,584
Fair value losses on cash flow hedges (4) -
Exchange differences on translation of
foreign operations (8) (9)
Pension fund actuarial losses (26) -
Net change in available for sale investments (2) -
-------- --------
Net income recognised directly in equity 5,640 5,575
Profit for the year 881 870
less: Minority interests (32) -
-------- --------
Total recognised income and expense for the year 6,489 6,445
Dividends (321) (329)
Employee share schemes costs 9 -
Increase in share capital/share premium 1 1
Allocation of Treasury shares 4 (1)
-------- --------
At 31 December 6,182 6,116
======== ========
* Includes £602m of intra-group subordinated debt capital attributed to the SRC.
** Includes £353m net assets of managed pension funds business.
*** Includes £493m of convertible debt, £602m of senior debt which has been
onlent to the Long Term Fund, £788m representing the net proceeds from the 2002
Rights Issue and £188m representing the aggregate investment returns.
===============================================================================
Legal & General Group Plc P15
Notes to Financial Statements - EEV Basis
Year ended 31 December 2004
-------------------------------------------------------------------------------
10. Alternative assumptions
The discount rate appropriate to any investor will depend on the investor's own
requirements, tax and perception of the risks associated with the anticipated
cash flows to shareholders. The table below shows the effect of alternative
economic and non-economic assumptions on the long term embedded value and new
business contribution.
Effect on embedded value at 31 December 2004
Sensitivity to economic
assumptions: 1% lower 1% higher 1% higher 1% lower
risk risk equities/ equities/
As discount discount property property
published rate rate yields yields
£m £m £m £m £m
Life and pensions
- UK 4,445 288 (250) 220 (221)
- International 707 52 (45) 6 (8)
-------- -------- -------- -------- --------
Total life and pensions 5,152 340 (295) 226 (229)
Managed
pension funds 353 8 (8) n/a n/a
-------- -------- -------- -------- --------
Total covered business 5,505 348 (303) 226 (229)
======== ======== ======== ======== ========
Sensitivity to 10% dec- 10% dec- 10% dec- 10% dec-
non-economic assumptions: rease in rease in rease in rease in
maint- lapse mortality mortality
As enance rates (UK (other
published expenses Annuities) business)
£m £m £m £m £m
Life and pensions
- UK 4,445 31 40 (215) 59
- International 707 9 27 - 97
-------- -------- -------- -------- --------
Total life and pensions 5,152 40 67 (215) 156
Managed
pension funds 353 10 8 n/a n/a
-------- -------- -------- -------- --------
Total
covered business 5,505 50 75 (215) 156
======== ======== ======== ======== ========
Effect on new business contribution for the period
Sensitivity to 1% lower 1% higher 1% higher 1% lower
economic assumptions: risk risk equities/ equities/
As discount discount property property
published rate rate yields yields
£m £m £m £m £m
Life and pensions
- UK 241 51 (45) 29 (29)
- International 35 17 (14) 0 0
-------- -------- -------- -------- --------
Total life and pensions 276 68 (59) 29 (29)
Managed
pension funds 36 2 (2) n/a n/a
-------- -------- -------- -------- --------
Total
covered business 312 70 (61) 29 (29)
======== ======== ======== ======== ========
Sensitivity to 10% dec- 10% dec- 10% dec- 10% dec-
non-economic assumptions: rease in rease in rease in rease in
maint- lapse mortality mortality
As enance rates (UK (other
published expenses Annuities) business)
£m £m £m £m £m
Life and pensions
- UK 241 10 20 (17) 23
- International 35 2 5 - 21
-------- -------- -------- -------- --------
Total life and pensions 276 12 25 (17) 44
Managed
pension funds 36 2 2 n/a n/a
-------- -------- -------- -------- --------
Total
covered business 312 14 27 (17) 44
======== ======== ======== ======== =======
In calculating the alternative values all other assumptions are left unchanged.
===============================================================================
Legal & General Group Plc P16
Assumptions
Year ended 31 December 2004
-------------------------------------------------------------------------------
11. Assumptions
UK life and pensions
i. The assumed future pre-tax returns on fixed interest and RPI linked
securities are set by reference to redemption yields available in the market at
the end of the reporting period. The corresponding return on equities and
property is equal to the fixed interest gilt assumption plus the appropriate
risk premium. An asset mix consistent with the current investment policy and
future management intentions has been assumed within the projections. The
economic assumptions were:
EEV AP EEV AP
2004 2004 2003 2003
Equity risk premium 3.0% 2.6% 3.0% 2.6%
Property risk premium 2.0% 2.6% 2.0% 2.6%
Investment return
- Gilts:
- Fixed interest 4.5% 4.5% 4.7% 4.7%
- RPI linked 4.5% 4.5% 4.6% 4.6%
- Non Gilts:
- Fixed interest 4.9% - 5.3% 4.9% - 5.3% 5.1% - 5.5% 5.1% - 5.5%
- RPI linked 4.7% - 5.1% 4.7% - 5.1% 5.1% - 5.4% 5.1% - 5.4%
- Equities 7.5% 7.1% 7.7% 7.3%
- Property 6.5% 7.1% 6.7% 7.3%
Risk margin 3.0% 2.5% 3.0% 2.5%
Risk discount rate
(net of tax) 7.5% 7.0% 7.7% 7.2%
Inflation
- Expenses/earnings 3.8% 3.8% 3.8% 3.8%
- Indexation 2.8% 2.8% 2.8% 2.8%
The assumed returns on non-gilt securities are net of an allowance for default
risk of 0.2% p.a. (2003: 0.2% p.a.), other than for certain government-supported
securities where no such allowance is made.
ii. Assets are valued at market value. For the projection of fixed
interest and RPI linked investment returns, asset values are adjusted to reflect
the assumed interest and inflation rates.
iii. The value of the Sub-Fund is the discounted value of total projected
investment returns over its lifetime.
iv. Future bonus rates have been set at levels which would fully utilise
the assets supporting the policyholders' portion of the with-profits business.
The proportion of profits derived from with-profits business allocated to
shareholders has been assumed to be 10% throughout.
v. The value of in-force business reflects the cost of providing for
benefit enhancement or compensation in relation to certain products including
administration expenses.
===============================================================================
Legal & General Group Plc P17
Assumptions
Year ended 31 December 2004
-------------------------------------------------------------------------------
vi. Other actuarial assumptions have been set at levels commensurate with
recent operating experience, including those for mortality, morbidity,
persistency and maintenance expenses (excluding the development costs referred
to above). These are reviewed annually. An allowance is made for future
improvements in annuitant mortality based on experience and externally
published data. For end 2004, male annuitant mortality is assumed to improve in
accordance with CMI Working Paper 1, projection MC for experience and the
average of projections MC and LC for statutory reserving. Female annuitant
mortality is assumed to improve in accordance with the MC projection from
CMI Working Paper 1 for statutory reserving and at 70% of this rate for
experience.
vii. The subordinated debt capital has been included in the embedded value
at the face value of £602m.
viii. Projected tax has been determined assuming current tax legislation
and rates.
ix. EEV results are computed on an after tax basis and are grossed up to
the pre-tax level for presentation in the profit and loss account. The tax rate
used for grossing-up is the corporation tax rate of 30% (2003: 30%), except for
the profit attributable to shareholder net worth, where the rate used is derived
from the tax attributed to the contribution from shareholder net worth in the
MSS accounts. To arrive at operating profit, the contribution from shareholder
net worth is grossed up at a rate to reflect the tax associated with a longer
term investment return.
UK managed pension funds
x. The UK life and pensions economic assumptions are used. All contracts
are assumed to lapse after 10 years. Fees are projected on a basis, which
reflects current charges or, if less, anticipated charges. New business consists
of monies received from new clients and incremental receipts from existing
clients, and excludes the roll-up of the investment returns. Development costs
relate to strategic systems.
International
xi. Key assumptions are:
EEV AP EEV AP
2004 2004 2003 2003
% % % %
USA
Reinvestment rate 4.9 4.9 4.8 4.8
Risk margin 3.0 2.5 3.0 2.5
Risk discount rate (net of tax) 7.3 6.8 7.3 6.8
Europe
Government bond return 3.8 3.8 4.5 4.5
Risk margin 3.0 3.5 3.0 3.5
Risk discount rate (net of tax) 6.8 7.3 7.5 8.0
Stochastic calculations
xii. The time value of options and guarantees is calculated using
consistent economic and non-economic assumptions to those used for the
deterministic embedded value calculations.
===============================================================================
Legal & General Group Plc P18
Assumptions
Year ended 31 December 2004
-------------------------------------------------------------------------------
This section describes the models used to generate future investment
simulations, and gives some sample statistics for the simulations used. A single
model has been used for UK and international business, with different economic
assumptions for the various economies.
Model
Government nominal interest rates are generated using a LIBOR Money Market Model
projecting full yield curves at annual intervals. The model provides a good fit
to the initial yield curve.
The total annual returns on equities and property are calculated as the return
on 1 year bonds plus an excess return. The excess return is assumed to have a
lognormal distribution. Corporate bonds are modelled separately by credit rating
using stochastic credit spreads over risk-free, transition matrices and default
recovery rates. The real yield curve model assumes that the real short rate
follows a mean reverting process subject to two normally distributed random
shocks.
Asset Classes
The significant asset classes are for:
• UK with-profits business - equities, property and fixed rate bonds of
various durations;
• UK annuity business - fixed rate and index-linked bonds of various
durations; and
• International business - fixed rate bonds of various durations.
Summary Statistics
The following tables set out means and standard deviations (StDev) of future
returns as at 31 December 2004 for the most significant asset classes.
Correlations between asset classes have been set based on an internal assessment
of historical data.
10-year return 20-year return
Mean1 StDev2 Mean1 StDev2
UK Business (Sterling)
Government bonds 4.7% 4.9% 4.7% 3.5%
Corporate bonds 5.3% 3.4% 5.4% 3.8%
Property (excess returns) 2.0% 14.9% 2.1% 15.3%
Equities (excess returns) 3.1% 20.4% 2.9% 19.6%
European Business (Euro)
Long Government bonds3 3.9% 6.7% 4.6% 7.6%
Short Government bonds4 3.9% 3.8% 4.6% 7.8%
US Business (US Dollar)
Long Government bonds3 4.6% 7.8% 5.5% 8.7%
1 Other than for equities and property, means calculated as excess of 1
year bond asset return means plus 1 year bond means. Mean equity and property
excess returns calculated as excess of 1 year bond asset return means.
Each mean is derived by calculating the accumulated value of a unit asset
invested to time n years for each simulation, averaging the resultant values
across all simulations, then calculating the equivalent annual return required
to give this average accumulation (by taking the nth root of the average
accumulation and deducting 1).
2 Standard deviations are calculated by accumulating a unit investment for
n years in each simulation, taking the natural logarithm of the result,
calculating the variance of this statistic, dividing by n and taking the square
root. Equities and property values use excess returns. The results are
comparable to implied volatilities quoted in investment markets.
3 Long-term bonds are defined to be 10-year zero-coupon bonds.
4 Short-term bonds defined to be 1 year duration.
===============================================================================
Legal & General Group Plc P19
Assumptions
Year ended 31 December 2004
-------------------------------------------------------------------------------
Risk discount rate
The risk discount rate is scenario-dependent within the stochastic projection.
It is calculated by applying the deterministic risk margin to the risk-free rate
in each stochastic projection.
Sensitivity calculations
vi. A number of sensitivities have been produced on alternative assumption
sets to reflect the sensitivity of the embedded value and the new business
contribution to changes in key assumptions. Relevant details relating to each
sensitivity are:
- 1% variation in discount rate - a one percentage point increase
/decrease in the risk margin has been assumed in each case (for example a 1%
increase in the risk margin at end 2004 would result in a 4% risk margin).
- 1% variation in equity/property yields - a one percentage point
increasedecrease in the equity/property assumed investment returns, excluding
any consequential changes for example to risk discount rates or valuation bases,
has been assumed in each case (meaning for example a 1% increase in equity
returns would increase assumed total equity returns from 7.5% to 8.5%).
- 10% decrease in maintenance expenses, excluding any
consequential changes for example to valuation expense bases or potentially
reviewable policy fees (meaning a 10% reduction on a base assumption of £10 per
annum would result in a £9 per annum expense assumption).
- 10% decrease in assumed lapse rates, incorporating a 10%
reduction in lapse, surrender and premium cessation assumptions (meaning a 10%
reduction on a base assumption of 7% would result in a 6.3% lapse assumption).
- 10% decrease in both mortality and morbidity rates, excluding
any consequential changes for example to valuation bases or potentially
reviewable risk charging bases (meaning for example if base experienced
mortality is 90% of a standard mortality table then for this sensitivity the
assumption is set to 81% of the standard table).
The sensitivities for UK life and pensions allow for any material changes to the
cost of financial options and guarantees but, as indicated above, do not allow
for any changes to reserving bases or capital requirements within the
sensitivity calculation. The sensitivities in our International businesses do
not allow for changes to financial options and guarantees.
===============================================================================
Legal & General Group Plc P20
Notes to Financial Statements - EEV Basis
Year ended 31 December 2004
-------------------------------------------------------------------------------
12. Embedded value
Reconciliation of in-force business
EEV AP
£m £m
Long term in-force business asset included in the
balance sheet 2,535 2,764
Sub-Fund (245) (245)
Deferred acquisition costs 731 742
Deferred tax on contribution * 358 397
Other miscellaneous adjustments ** 128 42
-------- --------
Value of in-force business 3,507 3,700
======== ========
Reconciliation of shareholder net worth
- UK (SRC) 2,196 2,233
- USA 488 475
- Netherlands 84 48
- France 64 48
- Managed pension funds 162 163
- Other assets (on the IFRS / MSS basis) 677 409
-------- --------
Shareholders' equity on the IFRS / MSS basis 3,671 3,376
Purchased interests in long term business (24) (24)
Sub-Fund 245 245
Deferred acquisition costs (731) (742)
Deferred tax on contribution * (358) (397)
Other miscellaneous adjustments (128) (42)
######## ########
Shareholder net worth of long term business : : : :
operations on the EEV / AP basis : 1,998: : 2,007:
Other assets on the IFRS / MSS basis : 677: : 409:
######## ########
Shareholder net worth on
the EEV / AP basis 2,675 2,416
======== ========
Reconciliation of shareholders' equity
Shareholders' equity on the IFRS / MSS basis 3,671 3,376
Less: Purchased interests in long term business (24) (24)
EEV / AP long term in-force business asset 2,535 2,764
-------- --------
Shareholders' equity on the EEV / AP basis 6,182 6,116
======== ========
* Deferred tax represents all tax which is expected to be paid under current
legislation, including tax which would arise if shareholders' backing assets
were eventually distributed.
** The increase in other miscellaneous adjustments is primarily due to the
different treatment of sterling reserves under EEV compared with IFRS.
===============================================================================
Legal & General Group Plc P21
Notes to Financial Statements - EEV Basis
Year ended 31 December 2004
-------------------------------------------------------------------------------
13a. Reconciliation of embedded value on the AP basis to the EEV basis
Life and pensions Managed
Intern- pension
UK ational Total funds Total
£m £m £m £m £m
AP basis 4,608 742 5,350 357 5,707
Required capital (8) (19) (27) (2) (29)
Time value of FOGs (32) (8) (40) - (40)
Valuation of Sub-Fund 34 - 34 - 34
Economic assumptions (125) (8) (133) (2) (135)
Pension deficit (45) - (45) - (45)
Other 13 - 13 - 13
-------- -------- -------- -------- --------
EEV basis 4,445 707 5,152 353 5,505
======== ======== ======== ======== ========
13b. Reconciliation of new business contribution on the AP basis to the
EEV basis after cost of capital
Life and pensions Managed
Intern- pension
UK ational Total funds Total
£m £m £m £m £m
AP basis 272 45 317 36 353
Required capital (8) (5) (13) - (13)
Time value of FOGs (3) (1) (4) - (4)
Economic assumptions (20) (4) (24) - (24)
-------- -------- -------- -------- --------
EEV basis 241 35 276 36 312
======== ======== ======== ======== ========
13c. Reconciliation of operating profit on the AP basis to the EEV basis
Life and pensions Managed
Intern- pension
UK ational Total funds Total
£m £m £m £m £m
AP basis 494 119 613 91 704
Value added from new business (31) (10) (41) - (41)
Effect of unwind of discount rate
- Value of in-force business 5 (1) 4 1 5
- Shareholder net worth 4 2 6 0 6
Other 2 3 5 0 5
-------- -------- -------- -------- --------
EEV basis 474 113 587 92 679
======== ======== ======== ======== ========
===============================================================================
Legal & General Group Plc P22
Special Purpose Audit Report
Year ended 31 December 2004
-------------------------------------------------------------------------------
Special Purpose Audit Report of PricewaterhouseCoopers LLP to the directors of
Legal & General Group Plc ('the Group') on its European Embedded Value ('EEV')
Supplementary Financial Information.
We have audited the accompanying consolidated EEV balance sheet of Legal &
General Group Plc ('the Group') as at 31 December 2004, the related consolidated
EEV profit and loss account for the year then ended and the related notes
(hereinafter referred to as 'the EEV supplementary financial information') set
out on pages 1 to 21.
Respective responsibilities of directors and PricewaterhouseCoopers
The directors of the Group are responsible for the preparation of the EEV
supplementary financial information which have been prepared as part of the
Group's conversion to EEV.
Our responsibilities, as independent auditors, are established in the United
Kingdom by the Auditing Practices Board, our profession's ethical guidance and
the terms of our engagement. Under the terms of engagement we are required to
report to you our opinion as to whether the EEV supplementary financial
information have been prepared, in all material respects, in accordance with the
basis of preparation set out in the Methodology section on pages 3 to 9 of the
EEV supplementary financial information.
This report, including the opinion, has been prepared for and only for the
Group for the purposes of assisting with the Company's conversion of the
supplementary financial information to EEV and for no other purpose. We do not,
in giving this opinion, accept or resume responsibility for any other purpose or
to any other person to whom this report is shown or into whose hands it may come
save where expressly agreed by our prior consent in writing.
Basis of audit opinion
We conducted our audit in accordance with Auditing Standards issued by the UK
Auditing Practices Board. An audit includes examination, on a test basis, of
evidence relevant to the amounts and disclosures in the EEV supplementary
financial information. It also includes an assessment of the significant
estimates and judgements made by the directors in the preparation of the EEV
supplementary financial information, and of whether the accounting policies are
appropriate to the Group's circumstances and adequately disclosed.
We planned and performed our audit so as to obtain all the information and
explanations which we considered necessary in order to provide us with
sufficient evidence to give reasonable assurance that the EEV supplementary
financial information are free from material misstatement, whether caused by
fraud or other irregularity or error. In forming our opinion we also evaluated
the overall adequacy of the presentation in the EEV supplementary financial
information.
Emphasis of matter
Without qualifying our opinion, we draw your attention to the fact that the
Methodology section on pages 3 to 9, which sets out the accounting policies used
in the preparation of the EEV supplementary financial information, explains why
there is a possibility that the EEV supplementary financial information may
require adjustment before their inclusion as comparative information in the
Group's first set of financial statements prepared on an EEV basis for the
year ended 31 December 2005. This is because International Accounting Standards
currently in issue and adopted by the EU are subject to interpretation issued
from time to time by the International Financial Reporting Interpretations
Committee and further standards may be issued by the International Accounting
Standards Board that will be adopted for financial years beginning on or after 1
January 2005.
Additionally, IFRS is currently being applied in the United Kingdom and in a
large number of other countries simultaneously for the first time. Furthermore,
due to a number of new and revised Standards included within the body of
Standards that comprise IFRS, there is not yet a significant body of established
practice on which to draw in forming opinions regarding interpretation and
application. Accordingly, practice is continuing to evolve. At this preliminary
stage, therefore, the full financial effect of reporting under IFRS as it will
be applied and reported on in the Group's first IFRS financial statements for
the year ended 31 December 2005 may be subject to change.
Opinion
In our opinion, the accompanying EEV supplementary financial information for the
year ended 31 December 2004 have been prepared, in all material respects, in
accordance with the basis set out in the Methodology section on pages 3 to 9,
which describes that the supplementary financial information have been prepared
in accordance with the twelve European Embedded Value principles as set out in
'European Embedded Value Principles'. The note includes the assumptions made by
the directors of the Group about the standards and interpretations expected to
be effective, and the policies expected to be adopted, when they prepare the
first complete set of supplementary financial statements of the Group on an
EEV basis for the year to 31 December 2005.
PricewaterhouseCoopers LLP
Chartered Accountants
London
23 May 2005
This information is provided by RNS
The company news service from the London Stock Exchange